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3 Aerospace-Defense Stocks to Watch Amid Supply Chain Woes

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The International Air Transport Association (IATA) made some encouraging projections, possibly driven by the improving trends in global air traffic, which should bode well for commercial jet makers. Solid deliveries, expected to be received by airlines next year, surely boost the prospects of jet manufacturers. An expansionary U.S. defense budget should benefit defense-oriented companies. However, the U.S. defense electronics supply chain disruption due to the COVID-19 pandemic remains a threat for stocks in the aerospace-defense space. Nevertheless, solid air traffic projections should keep investors interested in this industry. The frontrunners in the aerospace-defense industry are Lockheed Martin (LMT - Free Report) , Northrop Grumman (NOC - Free Report) and General Dynamics (GD - Free Report) .       


About the Industry

The Zacks Aerospace-Defense industry comprises companies that primarily design and manufacture heavy-built products like commercial as well as military jets and helicopters, tankers and other combat vehicles, missiles, combatant ships as well as auxiliary ships, submarines, bombs, guns, space transportation vehicles, military satellites and a few more. The industry also includes cyber security players who offer information technology (IT) services and C4ISR (command, control, communications, computers, intelligence, surveillance and reconnaissance) solutions. A portion of revenues comes from defense contractors, offering spare parts, aircraft modification, ship repair and overhaul services and supply chain management services.

3 Trends Shaping the Future of the Aerospace-Defense Industry

Improved Air Traffic Outlook Boosts Prospects: Global air traffic, which has been suffering since last March following the widespread outbreak of coronavirus worldwide, has been showing signs of improvement lately.  As estimated by IATA in October 2021, air passenger traffic measured by revenue passenger kilometers are projected to improve 51% in 2022 and reach 61% of the pre-crisis levels. This should bode well for commercial aerospace giants like Airbus and Boeing,, which have long borne the brunt of poor air travel in the form of delayed jet deliveries and, in some cases, cancellation of their orders altogether by airlines. Notably, in 2022, airlines are scheduled to receive 1622 aircraft, which is above the 2019 tally. This should boost the top-line performance of commercial jet manufacturers and associated companies, thereby bolstering their near-term growth prospects.

Military Business Continues to Be a Growth Catalyst: While the commercial aerospace market has started to recover recently, the defense side of the industry has been consistently offering support, cushioned by steady government support. An expansionary budgetary amendment adopted by the former U.S. government for defense has acted as a major catalyst for this. Under Donald Trump, defense spending increased nearly 15%, as stated by a Bloomberg article. A similar trend is being followed by the current U.S. administration as well. President Biden’s fiscal 2022 defense budget request includes an investment option worth $715 billion for the Department of Defense (DoD), which indicates a 1.6% increase from the prior-year’s enacted amount of $703.7 billion. Such improved budgetary provisions set the stage for industry players who are more focused on the defense business.
 
Supply Chain Issues May Hurt: Supply chain disruption has been observed in the Aerospace and Defense industry, of late, courtesy of the pandemic-induced lower aircraft demand and restrictions on the movement of people and goods. This primarily affected smaller suppliers, especially those with heavy exposure to commercial aerospace and the aftermarket business. In particular, the United States is facing shortages and security vulnerabilities with printed circuit boards and integrated circuit substrates crucial to its weapons systems, as published in a Forbes report. Although the situation is improving, the entire impact of coronavirus on the global economy and the threat of U.S. defense electronics supply-chain disruption are unlikely to subside soon. This in turn might keep the growth trajectory of the U.S. aerospace and defense industry constricted in the near term.

Zacks Industry Rank Indicates Bleak Prospects

The Zacks Aerospace-Defense industry is housed within the broader Zacks Aerospace sector. It currently carries a Zacks Industry Rank #183, which places it in the bottom 28% of more than 250 Zacks industries.

The group’s Zacks Industry Rank, which is basically the average of the Zacks Rank of all the member stocks, indicates dull near-term prospects. Our research shows that the top 50% of the Zacks-ranked industries outperforms the bottom 50% by a factor of more than 2 to 1.

The industry’s position in the bottom 50% of the Zacks-ranked industries is due to a negative  earnings outlook for the constituent companies in aggregate. Looking at the aggregate earnings estimate revisions, it appears that analysts have lost confidence in this group’s earnings growth potential over the past few months. Evidently, the industry’s earnings estimate for the current fiscal year has gone down 23.9% to $5.01 since July 2021.

Before we present a few aerospace-defense stocks that you may want to add to your portfolio, let’s take a look at the industry’s recent stock market performance and valuation picture.

Industry Lags S&P 500 & Sector

The Aerospace-Defense industry has underperformed the Zacks S&P 500 composite as well as its own sector over the past year. The stocks in this industry have collectively lost 27.5%, while the Aerospace sector has declined 8.1%. In contrast, the Zacks S&P 500 composite has risen 31.5% in the said timeframe.

One-Year Price Performance



 

Industry's Current Valuation

On the basis of the trailing 12-month EV/Sales ratio, which is used for valuing capital-intensive stocks like aerospace-defense, the industry is currently trading at 1.56, compared with the S&P 500’s 4.72 and the sector’s 2.13.

Over the past five years, the industry has traded as high as 1.98X, as low as 1.52X, and at the median of 1.79X, as the charts show below.
 

EV-Sales Ratio TTM

3 Aerospace-Defense Stocks to Keep in Your Watchlist

Lockheed Martin: Based in Bethesda, MD, Lockheed Martin is the largest defense contractor in the world. Its product line includes renowned fighter jets like F-35, F-16, C-130J along with combat-proven missiles like Terminal High Altitude Area Defense System (THAAD) and PAC-3 Missiles. It is also the manufacturer of the Aegis Combat System, which is referred to as the world’s most advanced combat system. Lockheed Martin is set to complete its Aerojet Rocketdyne’s acquisition this year, which will enable it to expand its footprint in the rocket engine market, apart from boosting its hypersonic technology-related product line.

Lockheed Martin currently boasts a long-term earnings growth estimate of 3.6%. The company delivered an average earnings surprise of 63.28% in the last four quarters.  LMT currently carries a Zacks Rank #3 (Hold).

Price & Consensus: LMT

Northrop Grumman: Based in Falls Church, VA, Northrop Grumman is one of the top largest U.S. defense contractors in terms of revenues. Its product line is well positioned in high-priority categories, such as defense electronics, unmanned aircraft and missile defense. Northrop Grumman recently entered into an accelerated share repurchase (ASR) agreement with Goldman Sachs & Co. LLC to repurchase $500 million of its common stock. The ASR is in addition to the previously planned repurchases, and as a result, the company is now targeting greater than $3.5 billion of repurchases in 2021. This reflects its solid financial position.

The Zacks Consensus Estimate for Northrop Grumman’s 2021 earnings has risen 2.7% in the past 60 days and indicates a year-over-year increase of 3.6%. The company delivered an average earnings surprise of 8.2% in the last four quarters.  NOC currently holds a Zacks Rank #3. You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

Price & Consensus: NOC


 

General Dynamics: Based in Falls Church, VA, General Dynamics is the leading designer and builder of nuclear-powered submarines and a leader in surface combatants and auxiliary ship design and construction for the U.S. Navy. It is also a premier manufacturer and integrator of land combat solutions worldwide along with renowned business jets. General Dynamics appears to be on track for the entry of the G700 business jet into service in the fourth quarter of 2022 and G800 in the next six to nine months, which is expected to boost its revenues and earnings next year.

The Zacks Consensus Estimate for General Dynamics’ 2021 earnings has risen 0.3% in the past 60 days and indicates a year-over-year increase of 12.7%. The company delivered an average earnings surprise of 4.8% in the last four quarters. GD currently holds a Zacks Rank #3.

Price & Consensus: GD


 



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